On 17 July 2013 the Minister of Finance appointed a tax review committee, headed by Judge Dennis Davis (the “Davis Committee”) to make recommendations for possible tax reforms in South Africa (“SA”).
The Davis Committee was required to take into account recent international developments and, in particular, to address concerns about base erosion and profit shifting (“BEPS”) which was identified as a risk to tax revenues, tax sovereignty and the tax fairness of countries by the Organisation for Economic Co-operation and Development (“OECD”) in its report published on 12 February 2013. A 15-point Action Plan was developed by the OECD to address BEPS and to ensure that profits are taxed where the economic activities generating the profits are performed and where value is created. The purpose of the OECD ‘Action Plan 13: Re-examine Transfer Pricing Documentation’ was to re-assess transfer pricing documentation requirements with the purpose of obtaining information from taxpayers so as to enable tax administrations to identify transfer pricing risks.
The Davis Committee prepared an interim report setting out its position on the OECD BEPS Action Plan on 23 December 2014 (the “Report”). The salient contents of the Report dealing with Transfer Pricing Documentation is set out below.
South Africa’s transfer pricing legislation came into effect on 1 July 1995 and was followed by Practice Note 2 and Practice Note 7 which provided taxpayers with guidance on how the South African Revenue Service (“SARS”) intended to apply the legislation. Practice Note 2 covered thin capitalisation whilst Practice Note 7 dealt with transfer pricing. As of 1 April 2012, SARS made several amendments to the transfer pricing legislation and Practice Note 2 was withdrawn (it is now only applicable to years of assessment commencing before 1 April 2012). A draft Interpretation Note was subsequently issued by SARS on thin capitalisation but it has not yet been finalised.
The fundamental change that was made to SA’s transfer pricing legislation was that a taxpayer must make any transfer pricing adjustments that might be required in the calculation of its taxable income itself whereas previously transfer pricing adjustments could only be made by SARS in terms of the exercise of a discretion by SARS itself. This places a significantly greater onus on taxpayers to confirm the arm’s length nature of its connected party transactions. This onus exists on taxpayer’s, regardless of whether or not the taxpayer has transfer pricing documentation, but the OECD’s view is that one of the purposes of transfer pricing documentation guidelines is to ensure that taxpayers can make an assessment of their own compliance with the arm’s length principle.
In this regard, in terms of the Report, the Davis Committee is of the view that the current Practice Note 7 contains unclear documentation guidelines for taxpayers in SA and consequently, the Report makes the following recommendations to revise the transfer pricing documentation guidelines in SA:
- Practice Note 7 must be revised and updated to be in line with the OECD revised Transfer Pricing Documentation Guidelines and the finalisation of the draft Interpretation Note must be prioritized.
- The OECD’s recommendation that countries should adopt a standardised approach to transfer pricing documentation that follows a three-tiered structure consisting of a master file, a local file and country-by-country reporting should also be adopted in SA.
- The three-tiered structure should however, only be compulsory for large multinational businesses with a group turnover of over R1 billion.
- SARS should balance requests for transfer pricing documentation against the expected cost and administrative burden to the taxpayer of creating it.
- SA should implement objective materiality standards for local file purposes which are commonly understood and accepted in commercial practice.
- The country-by-country report for SA should contain additional transactional data regarding related party interest payments, royalty payments and especially related party service fees so that SARS may perform risk assessments where it is difficult to obtain information on the operations of a multinational group.
- In respect of the timing for each of the three reports, SARS should set out what its expectations are, as the OECD recommends that the local file should be finalised no later than the due date for the filing of the tax return; the master file should be updated by the tax return due date for the ultimate parent of the group; and the country-by-country report, should be submitted when the final statutory financial statements are finalised (which may be after the due date for tax returns).
- The master file, the local file and the country-by-country report should be reviewed and updated annually and that database searches for comparables be updated every 3 years.
- SARS should start to build a database of comparable information as the OECD recommends that the most reliable information is usually local comparables.
Notwithstanding the recommendations above, the Report reiterates the general rule that the compliance costs related to the preparation of transfer pricing documentation should not be disproportionate to the benefits thereof. However, taxpayers choosing not to prepare documentation will be at risk, as it may be more difficult to discharge the onus of proving that an arm’s length price has been established, especially in light of the fact that such onus is now placed on taxpayers in South Africa.